Inverse ETFs and Hedging
All inverse ETF’s, including double and triple inverse ETF’s, are in the process of discounting (i.e. price discovery) a “volatility” premium due to institutional hedging in times of extreme market stress. When gamma explodes because of the impact of volatility on derivative pricing, hedging becomes much more difficult as “prudent” hedges seem to malfunction all of a sudden.
During these periods, any instrument that achieves a direct and efficient (i.e. liquid) hedge experiences an acute supply shortage. So, regardless of their “class” or “sector”, the correlation of these triple inverse ETF’s have all spiked to 1 (like everything else) and will, together as a group, experience multi-sigma moves (e.g. 5 or 6 Sigma).
The reason has a lot to do with the impact of volatility, which amplifies a stocks move due to the logarithmic nature of these derivatives, which are, at their core, repurchase or “swap” agreements.
In layman’s terms, when VIX is engaged in a multi-day spike, these ETF’s are the exclusive instrument of choice for the professional trader and therefore become the primary focus on an acute basis (don’t get married to the strategy).
TZA, BGZ, FAZ, SKF, SDS, SRS, DIG, DXO, ERY, DOG, SH, SMN, DXD, FXP, MZZ, EFU, EEV, DUG, QID, TWM
Note, I’ve only listed the most liquid names above.
